Mechanics of a Default

[BeFree]

Seems to me that by increasing the debt ceiling it will allow the treasury to sell more bonds.

If Treasury is not allowed to sell more bonds then it won't have the means to pay ALL the bills due.

It can pay some, even most of the bills due, but some bills will have to be unpaid.

So which bills will go unpaid? The electric bill? The gas bill to BP? The rent?

[leveymg]

1. That's not going to happen. The Fed will cover the Treasury just as it did the banks in QE2 - $16T

The Fed isn't under the control of either the Exec or the Leg branch. They can cover the debt by their own authority. It's an extra-Constitutional body, a fact that was previously treated by some as threatening but which now becomes useful.

This sort of political/economic "crisis" is why the Fed was created.

[originalpckelly]

2. No, they can't.

The government still has to be authorized to borrow by Congress by, you guessed it, the raising debt ceiling.

[leveymg]

3. Yes they can, and they did to the tune of $16T in QE2. That wasn't authorized by Congress.

Call this QE3. But the Fed will step in on Tues. if there is no debt ceiling agreement and announce it will lend money with interest to the Treasury on its own Charter powers. Wiki:

Emergencies

According to the Federal Reserve Bank of Minneapolis, "the Federal Reserve has the authority and financial resources to act as 'lender of last resort' by extending credit to depository institutions or to other entities in unusual circumstances involving a national or regional emergency, where failure to obtain credit would have a severe adverse impact on the economy."<36> The Federal Reserve System's role as lender of last resort has been criticized because it shifts the risk and responsibility away from lenders and borrowers and places it on others in the form of inflation.<37>

[divvy]

7. Citation please ......

You are assuming that the fed and the us treasury are the same. When has the fed EVER loaned money to the us treasury before?

I suspect that you really dont understand the capital markets that well. So, please show me some proof. I will not be wasting my time looking for evidence to support your claim

[originalpckelly]

9. They do it indirectly by buying treasury securities, but not that much.

It was in the range of hundreds of billions, not 10+ trillion.

The poster has confabulated things.

[divvy]

12. The problem is that the US Treasury is NOT ALLOWED to hold more auctions

that is what the debet ceiling is about.

there is some very serious misconceptions in this thread

[originalpckelly]

14. Yes, that's my point.

:P

We agree, I think.

[leveymg]

20. Not one bit of confabulation - QE2 amounted to $16T

The Fed has power to lend money to banks and governmental bodies as well as to buy-back (repo) Treasuries. The Repo market is just one side of the Fed's virtually unlimited power to sustain the U.S. Treasury in an emergency.

[originalpckelly]

24. If the Federal reserve just *poof* created 16 trillion dollars...

there would be hyper-inflation. That's higher than the GDP, which is in the $14 trillion range.

You can see QE2 on the M1 data here available from the St. Louis Fed:
http://research.stlouisfed.org/fred2/series/M1?cid=25

You notice near the end how it jumps about $600 billion, that's QE2. The Fed just increased the amount of electronic credits in its account, and went out and bought treasuries. QE2, was about $600 billion in other words.

The $16 trillion was a bunch of loans made to private companies that helped them in the financial crisis. They are short term and low interest and they overall don't actually increase the supply of money, because they are paid back quite quickly. The Fed did this because all these companies had terrible balance sheets filled with toxic assets, that could have brought down the entire economy.

[leveymg]

29. No. The Fed didn't create those $16T in funds, it was lent with interest. No inflation there.

[originalpckelly]

33. You are correct, but not about what QE2 is.

They are different things. Those loans were issued as a sort of a lender of last resort type deal. That's why we could *not* really know at the time who the banks were, because it is seen as a stigma to go to the lender of last resort, it means a financial institution has taken on too much risk it cannot handle.

*updated to add not, a very important part of the sentence

[leveymg]

16. Here's an article published by the St Louis Federal Reserve in 2009 re: "emergency powers"

The Regional Economist | January 2009
If Fed Becomes Super Regulator, Politicians Would Be Its Kryptonite

By Sharon K. Blei

http://stlouisfed.org/publications/re/articles/?id=1323
Drawing upon long-dormant emergency powers as lender of last resort, the Federal Reserve has taken unprecedented steps to shore up the financial system. If, as a result of these precedents, the Federal Reserve’s role as a regulator is expanded, the central bank will probably face new challenges in executing its traditional responsibilities and preserving its independence against political pressure. Thus, changes in the role of the Federal Reserve should be carefully considered, bearing in mind the importance of its role in monetary policy and the payment system—and the importance of protecting these functions from political and financial pressures.
The Fed Responds to Crisis

The challenges presented by the subprime meltdown and the subsequent strain in global financial markets have dramatically reshaped the financial landscape in the U.S. Since the onset of the crisis in August 2007, the country has witnessed a series of prominent bank failures: Countrywide, IndyMac and Washington Mutual (by far the largest commercial bank failure in American history); the demise of America’s five major investment banks; the bailout of mega-insurer American International Group (AIG); and the decline of mortgage titans Fannie Mae and Freddie Mac. Faced with these extraordinary developments, the Federal Reserve—to which all eyes were turned for rescue—took upon itself the mission of managing and containing the crisis.

Assuming responsibility not only for those banks under its supervision, but for the financial system as a whole, the central bank drew upon long-dormant emergency powers and took bold steps: It enhanced financial institutions’ access to liquidity by deploying an array of new short-term liquidity facilities; expanded reciprocal currency arrangements with foreign central banks; engineered and backed JP Morgan’s takeover of ailing investment bank Bear Stearns; agreed to lend to Fannie Mae and Freddie Mac; provided an emergency credit line to AIG; and worked out with the U.S. Treasury an ambitious $700 billion emergency rescue package for the American financial services industry.

Thus, the Federal Reserve, established nearly a century ago as lender of last resort to tackle financial panics, emerged in a new, broader guise—that of the nation’s financial system savior.
A Systemwide Regulator?

Why has the Federal Reserve assumed this extended role? The reasons appear to be multiple. First, the Federal Reserve is the lender of last resort and has a monopoly over the supply of liquidity to the financial system. This role provides the central bank with both the tools and the expertise for managing and containing systemic disruptions. Second, the Federal Reserve plays a key role in providing payment services and overseeing the payment system, the integrity of which is essential to financial stability. The Federal Reserve also enjoys an unmatched reputation for technical skill and nonpartisanship, the ability to wield moral suasion and a unique “primus inter pares” (first among equals) status among federal regulators, placing it in the prime position for leading national rescue efforts. In the global arena, its close relationship with foreign central banks and its high international acclaim enable the Federal Reserve to coordinate multinational endeavors to shore up crumbling financial markets. Faced with the dramatic developments in the financial system, the Federal Reserve answered a call no other federal agency was better-suited—or willing—to answer.

To date, regulators of financial institutions in the U.S. have been mandated to focus on the prudential issues, namely, business conduct and financial conditions of individual institutions. The recent financial shakeout vividly demonstrates the need for a systemwide, “macro-prudential” approach to financial regulation. Unlike micro-prudential regulation, which focuses on the financial condition of single institutions, the systemwide approach’s field of vision is the financial system as a whole, focusing on common exposures, linkages and interdependencies among financial institutions.

It has been suggested that a systemwide regulator, entrusted with the responsibility for maintaining financial system stability, should be able to either collect or access the information required for the evaluation of the systemic risks associated with certain industry-wide practices, common exposures or default by a financial institution, and should be able to wield both the authority and the tools to intervene when needed. In the eyes of many, the Federal Reserve is the natural candidate for the role. A “blueprint” for regulatory overhaul released by the U.S. Department of the Treasury last March (the Paulson plan) recommends mandating the Federal Reserve as “market stability regulator.”1

Whether formalized or not, the Federal Reserve’s extended role in financial oversight, alongside its long-existing roles in maintaining price stability and promoting economic performance, raises important challenges. One such challenge is the potential conflict between micro- and macro-prudential regulatory objectives. Micro-prudential regulation is pro-cyclical by nature—both because capital requirements and accounting rules enhance the pro-cyclicality already inherent in credit markets and also because prudential regulators tend to be stricter in times of economic weakness and laxer during expansion. The systemwide approach to regulation, on the other hand, aims to stabilize systemic shocks to financial markets and is, therefore, counter-cyclical by definition. Regulatory measures that are desirable from a micro-prudential point of view may seem, therefore, detrimental from a systemic standpoint. (For example, taking corrective action against a financial institution might be well-justified as far as prudential regulation goes, yet undesirable from a system-wide perspective, since doing so may further deteriorate that institution’s financial condition and increase the risk it poses to the system.)

Acquiring the information essential to executing the role of systemwide regulator—namely, real-time data about a vast array of financial institutions, their financial condition, structure and the contractual linkages between them—presents additional challenges. First, there are the technical difficulties and non-negligible costs associated with collecting and processing such complex data—both to supervisors and institutions. Then, there’s the need for close collaboration with other regulators (public, private and even foreign), who may not be willing to cooperate.
(snip)

[originalpckelly]

8. OK, the Fed can lend to anyone, that I agree with.

They cannot, however, lend to the government without the Congress approving it.

QE2 was not the $16T loans, those were bridge loans made to PRIVATE institutions. That's why everyone is so pissed, because private companies got a shitload of money at low interest rates. And not all of those companies were even in America. (And then those private companies turned around and charged high interest rates to consumers.)

QE2 was a program of buying treasuries on the open market with money that was made out of thin air, like all money now, but this more so than the others.

[rdking647]

19. but the treasury cant borrow the money

the fed may be willing to lend but the treasury doesnt have the authority to borrow the extra money. thats the crux of the problem.

[leveymg]

22. The Fed can credit Treasury accounts in the private sector. The Treasury doesn't have to ask for it

That's what central banks do - they are an executive that controls how money flows back and forth between private and public sector institutions. The Treasury doesn't have to issue bonds for the Fed to credit accounts in the private sector - the Fed can lend directly, and will bypass the T-bill auctions markets to do so, if it has to.

T-bills are just a convenient market for distributing and pricing gov't debt. But, they aren't necessary for the Fed to credit accounts by the same amount.

[originalpckelly]

25. That would be unconstitional.

I can't see that anywhere in the Federal Reserve Act, either.

[leveymg]

30. Exactly. The Fed is an extra-constitutional body, intentionally, for this very reason.

Otherwise, this sort of political crisis would have ended the US a long time ago.

[Morizovich]

36. Default? No: Triage!

Thank you. Ms Ramsey.......

http://www.slate.com/id/2300207/

[BeFree]

4. Yep

The Fed IS bailing out the banks and it can bail out the government.

But what if the Republican default scenario were to take place? What would be the first unpaid bill?

The problem the treasury faces is that bills coming due are repayments of bonds with interest. Some of those bonds are held by SS, some by East Asians, some by rich corporations. Who will get the shaft first? Maybe Israel?

[divvy]

5. ..

sorry, it posted in the wrong spot

[leveymg]

6. There will be no default because the Fed will cover the revenue gap, at least temporarily under its

existing emergency powers.

This is why the money markets are NOT freaking out. The "crisis" is political kabuki theatre.

[divvy]

11. So, you think the Fed can print money?

I feel you are seriously wrong here.

[originalpckelly]

13. Yes, the Fed can "print money". That's why they're the central bank.

That's what central banks do!

That's what quantitative easing is. The Fed creates electronic credits in its account, and then goes out and buys treasuries on the open market. This is done through the NY Fed which has exclusive jurisdiction in open market operations.

The government still has to be authorized to create new securities to sell, however, and without this authorization (which raising the debt ceiling is) they cannot take on anymore debt.

[leveymg]

23. Yes and no.

Yes, the Fed issues and controls the flow of money. No, T-bill issues are not necessary for the Fed to continue issuing and control the flow of the money supply.

Does anyone at the Fed want to do it this way - no. Can they - yes.

[divvy]

41. Your argument is insane .... citation please

Show document which details how the US government will use money that the fed prints under these circumstances. Ok, the fed printed a dollar bill ..... HOW does this impact the treasury if NO TREASURY BONDS or BILLS can be issued?

What you are saying is .... just do what you have always done. Let the fed print and the us treasury sell bonds and bills. Did you not notice that this "crisis" is because the politicians will not allow the treasury to sell more bonds?

You are saying that the fed will print then SOMEHOW simply deposit the money in the treasury. You are wrong.

Did you learn this in church? Some fundamentalist churches have been preaching this crap along with constitutional law in their Sunday school classes. Once again ..... CITATION PLEASE. How does the fed deposit newly printed cash into the US Treasury without an auction?

[divvy]

40. Sorry, I forgot to include the word "just" with "print money"

Thank you for making my point.

[BeFree]

15. You're no fun

Why can't you just play along and act all distressed and stuff?
Don't you know this is, AGAIN, another 'End of the World' time?

The media is having a blast, teabaggers are being bubbled up, and Obama is milking the game for all it is worth, why do you feel you must monkeywrench the play?

I bet they have banned you from theaters because you keep getting up and spoiling the endings of movies, eh?

[originalpckelly]

21. I just looked through the Federal Reserve Act...

(What you can in only a few minutes)

I personally cannot see on its face a provision that would allow this. It seems that they don't have the ability to lend to the government or any agency of the government without being guaranteed that they would be paid back, which could not be guaranteed if it was an extra-constitutional debt, not authorized by the Congress.

If someone knows of the part of the law that allows this, please post it.

[originalpckelly]

27. It says this here:

"To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States."

Section 14, (b)2

http://www.federalreserve.gov/aboutthefed/section14.htm

So either they have to get it directly from the government, which means they have to be authorized to help the government by an increase in the debt ceiling, or they have to buy it on the open market from financial institutions that have treasuries (which would really help in this situation.)

[leveymg]

31. That's correct. The Treasury issues bonds, but plenty of federal agencies issue debt instruments

The Freddie Mac/Mae GSEs, for instance. Under the rubric of agency debts incurred, basically the whole federal government comes under the emergency powers of the Fed to sidestep the statutory limit on Treasury issues.

[divvy]

42. you are diverting the question ....

You have been asked for a citation to back your wild claims. NOBODY (but you) brought up agency debt.

[leveymg]

28. It's not all in the FR Act. Look to FDI regs: 12 CFR Sec. 201.2(e) of Regulation A of FDI Act

http://cfr.vlex.com/vid/201-2-definitions-19621270

Title 12: Banks and Banking

CHAPTER II: FEDERAL RESERVE SYSTEM

SUBCHAPTER A: BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

PART 201: EXTENSIONS OF CREDIT BY FEDERAL RESERVE BANKS (REGULATION A)

201.2 - Definitions.

For purposes of this part, the following definitions shall apply:

(a) Appropriate federal banking agency has the same meaning as in section 3 of the Federal Deposit Insurance Act (FDI Act) (12 U.S.C. 1813(q)).

(b) Critically undercapitalized insured depository institution means any insured depository institution as defined in section 3 of the FDI Act (12 U.S.C. 1813(c)(2)) that is deemed to be critically undercapitalized under section 38 of the FDI Act (12 U.S.C. 1831o(b)(1)(E)) and its implementing regulations.

(c)(1) Depository institution means an institution that maintains reservable transaction accounts or nonpersonal time deposits and is:

(i) An insured bank as defined in section 3 of the FDI Act (12 U.S.C. 1813(h)) or a bank that is eligible to make application to become an insured bank under section 5 of such act (12 U.S.C. 1815);

(ii) A mutual savings bank as defined in section 3 of the FDI Act (12 U.S.C. 1813(f)) or a bank that is eligible to make application to become an insured bank under section 5 of such act (12 U.S.C. 1815);

(iii) A savings bank as defined in section 3 of the FDI Act (12 U.S.C. 1813(g)) or a bank that is eligible to make application to become an insured bank under section 5 of such act (12 U.S.C. 1815);

(iv) An insured credit union as defined in section 101 of the Federal Credit Union Act (12 U.S.C. 1752(7)) or a credit union that is eligible to make application to become an insured credit union pursuant to section 201 of such act (12 U.S.C. 1781);

(v) A member as defined in section 2 of the Federal Home Loan Bank Act (12 U.S.C. 1422(4)); or

(vi) A savings association as defined in section 3 of the FDI Act (12 U.S.C. 1813(b)) that is an insured depository institution as defined in section 3 of the act (12 U.S.C. 1813(c)(2)) or is eligible to apply to become an insured depository institution under section 5 of the act (12 U.S.C. 15(a)).

(2) The term depository institution does not include a financial institution that is not required to maintain reserves under ? 204.1(c)(4) of Regulation D (12 CFR 204.1(c)(4)) because it is organized solely to do business with other financial institutions, is owned primarily by the financial institutions with which it does business, and does not do business with the general public.

(d) Transaction account and nonpersonal time deposit have the meanings specified in Regulation D (12 CFR part 204).

(e) Undercapitalized insured depository institution means any insured depository institution as defined in section 3 of the FDI Act (12 U.S.C. 1813(c)(2)) that:

(1) Is not a critically undercapitalized insured depository institution; and

(2)(i) Is deemed to be undercapitalized under section 38 of the FDI Act (12 U.S.C. 1831o(b)(1)(C)) and its implementing regulations; or

(ii) Has received from its appropriate federal banking agency a composite CAMELS rating of 5 under the Uniform Financial Institutions Rating System (or an equivalent rating by its appropriate federal banking agency under a comparable rating system) as of the most recent examination of such institution.

(f) Viable, with respect to a depository institution, means that the Board of Governors or the appropriate federal banking agency has determined, giving due regard to the economic conditions and circumstances in the market in which the institution operates, that the institution is not critically undercapitalized, is not expected to become critically undercapitalized, and is not expected to be placed in conservatorship or receivership. Although there are a number of criteria that may be used to determine viability, the Board of Governors believes that ordinarily an undercapitalized insured depository institution is viable if the appropriate federal banking agency has accepted a capital restoration plan for the depository institution under 12 U.S.C. 1831o(e)(2) and the depository institution is complying with that plan.



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[originalpckelly]

32. All that talks about is lending to banks in times of crisis.

Not our government.

[leveymg]

34. The Fed lending won't be to the Gov't, it will be to the banks to cover the loss of federal checks

Got it now?

I don't know how they intend to cover foreign lenders without FDI-insured accounts.

[divvy]

43. That is insane. You need to put up specific proof or shut up.

[rdking647]

18. they cant

the debt ceiling is 14.2T and there is 14.t trillion in bonds outstanding. when the fed did QE2 they bought bonds on the open maket with money they created out of thin air. This didnt change the amount of debt outstanding. so even if the fed did this again the treasury still wouldnt have more money to spend.

what they could do is have the treasury mint a trillion dollar coin. the fed buys it and that gives the treasury a trillion dollars to spend. Its legal under the coinage act and the rethugs cant do a thing to stop it.

[leveymg]

35. It's not about printing money - the mechanism is loans to banks from the Fed

The funds doesn't come from the Treasury, in either specie or platinum coin form - they're loans from the Fed, which has virtually unlimited emergency powers to lend, to the banks.

[divvy]

44. Citation please

again

[Cool Logic]

39. "what they could do is have the treasury mint a trillion dollar coin."

Except...printing money is a power that is delegated to the Congress.

Section 8 - Powers of Congress

Clause 5 - To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;

[brooklynite]

10. Treasury said it would outline spending priorities AFTER the markets close today.

[BeFree]

17. That's my question...

Who is gonna get the shaft? I think we should stick Canada. What are they gonna do? Invade us?

[originalpckelly]

26. I don't know, those Canadians are getting quite pissy these days.

I hear they put a CF-18 on a hockey team logo. The only problem is that it's an American plane. So. I don't know how that would work out. :P

[drm604]

37. I'm finding this thread confusing.

If the Fed lends to banks, or buys treasuries on the open market, How does that help the government meet it's obligations?

Banks are private institutions, right?

Buying treasuries on the open market gives money to the holders of those treasuries, not the government, right?

How does any of this put money in the hands of the government?

[BeFree]

38. Yo're not confused

But there are some on this thread who are.

The fed is probably hoping the congress decides to default. It will make them and their bankers easier to hide. The fed just got audited for the first time ever and now we face default for the first time ever? Co-inky-dink or planned?

[divvy]

45. You are not confused ..... There are reports of a tentative deal

There have been reports tonight of a tentative deal which will be announced tomorrow. Here are the highlights:

$2.8 trillion in deficit reduction with $1 trillion locked in through discretionary spending caps over 10 years and the remainder determined by a so-called super committee.

The Super Committee must report precise deficit-reduction proposals by Thanksgiving.

The Super Committee would have to propose $1.8 trillion spending cuts to achieve that amount of deficit reduction over 10 years.

If the Super Committee fails, Congress must send a balanced-budget amendment to the states for ratification. If that doesn't happen, across-the-board spending cuts would go into effect and could touch Medicare and defense spending.

No net new tax revenue would be part of the special committee's deliberations.

<end highlights>

This is what an actual deal would look like .... Without proper citation, I think leveymg's argument is magical thinking.